Most business relationships begin with trust. A supplier delivers, paperwork is exchanged, and a polite assurance follows: "The payment will be cleared soon." The Micro, Small and Medium Enterprises Development Act, 2006 ('MSMED Act' or 'the Act') was crafted for the moments when "soon" becomes "someday." Chapter V of the Act, titled DELAYED PAYMENTS TO MICRO AND SMALL ENTERPRISES, imposes time limits around buyer obligations and attaches a real cost to delay: compound interest at three times the Reserve Bank of India's Bank Rate, calculated with monthly rests. This, combined with a mandatory 75% pre-deposit to challenge awards, specific disclosure requirements in audited accounts, and adverse tax treatment for delayed payments, is designed to protect smaller suppliers and to discourage habitual late payment.
Small and Micro Enterprises are significant contributors and movers to our economy. As per the Press Release dated 22nd July, 2024 by the Ministry of Micro, Small and Medium Enterprises, the total contribution of this sector to the total GDP of India is around 30%. And their contribution in the field of exports is to the tune of 45% to 49% of the total Indian exports. Despite this, however, many still remain unaware of the protections available to them under law. This article explores the protections available under Chapter V of the MSMED Act, and offers practical pointers for SMEs to take full advantage of the protections made available through this legislation.
Who Is Protected?
Chapter V's protections apply to 'suppliers' who are micro or small enterprises that hold valid Udyam registration. Medium enterprises are outside this particular umbrella for delayed-payment remedies.
With effect from 1 April 2025, the classification thresholds of micro, small and medium enterprises are:
- Micro: investment up to ₹2.5 crore and turnover up to ₹10 crore
- Small: investment up to ₹25 crore and turnover up to ₹100 crore
- Medium: investment up to ₹125 crore and turnover up to ₹500 crore
When Does Time Start Running?
The buyer's payment window can be what the parties agree in writing, but never more than 45 days from 'acceptance' or 'deemed acceptance' of the goods or services. 'Appointed day' is explained as the day after 15 days from acceptance (or deemed acceptance, if no written objection is raised within those 15 days). After the appointed day or the contractual due date, as the case may be, statutory interest begins to run automatically.
As an illustrative example, consider a small tool-room that delivers parts on 1 June. If the buyer does not record a written objection within 15 days, acceptance is deemed. Even if the contract between the parties allows a payment window of 60 days, Chapter V caps the credit period at 45 days. From the day after that outer limit, statutory interest begins to run. Chapter V of the MSMED Act would prevail over any contractual understanding to the contrary between the parties.
Compound Interest and Monthly Rests
The Act imposes compound interest with monthly rests at three times the RBI Bank Rate (not the repo rate and not any negotiated rate). At the time of writing (i.e. 4 November 2025), the RBI Bank Rate is 5.75%; the statutory rate therefore stands at 17.25% per annum, compounding monthly. Because it compounds, the cost of delay accelerates the longer an invoice remains unpaid.
Protections Available to SMEsAt a Glance
- Cap on payment periods, with an overriding effect: While SMEs are permitted to contractually agree on a payment window for supply of their goods or services, the Act caps this window to 45 days. Thus, even if parties may contractually agree to a longer payment window, the provisions of the Act will prevail over the contractual understanding. This safeguard protects micro and small suppliers by curbing prolonged outstanding dues, reducing bad-debt risk, and preventing larger buyers from leveraging unequal bargaining power to delay payments. It keeps cash flows predictable, and suppliers off the financial precipice.
- Monthly compounding interest: The statutory interest rate (three times the prevailing RBI Bank rate, compounded monthly) is a severe deterrent to delayed payments. Because the interest is compounded every month, the burden rises faster than a simple annual rate suggests.
- A dedicated dispute resolution forum: The Micro & Small Enterprises Facilitation Council (MSEFC) is a dedicated forum that micro and small suppliers can access irrespective of where the buyer is located. This allows speedy and efficient resolution of any disputes, without resorting to the already clogged court system. The Act also envisages a tiered dispute resolution mechanism, with a 90-day resolution timeline: the Council first attempts conciliation; if that fails, it either arbitrates the matter itself or refers the dispute to an arbitral institution. New delayed-payment filings are now also being routed through the MSME Online Dispute Resolution (ODR) Portal, which guides users to the Samadhaan portal, an Indian government initiative under the Ministry of Labour & Employment for resolving employee grievances and industrial disputes online.
- Expensive to challenge an award: The Act has intentionally sought to make the challenge to an arbitral award issued by or under the MSEFC expensive, as a deterrent against malicious litigation used as a tool to avoid payments to SME suppliers. Section 19 of the Act mandates a deposit of 75% of the awarded sum as a precondition to initiate any challenge. The Hon'ble Supreme Court has, in Tirupati Steels v Shubh Industrial Component & Anr. (Civil Appeal No. 2941 of 2022), underscored that this pre-deposit is mandatory (courts may allow instalments in cases of genuine hardship though).
- Disclosure in annual financials: Audited buyers must disclose, in their annual financials, the principal outstanding to SME suppliers and the interest payable/paid under the MSMED Act, with specific break-ups. Separately, the Act itself bars income-tax deduction for MSME interest under Section 23. And since 1 April 2024, Section 43B(h) of the Income-tax Act makes any sum payable to micro or small enterprises beyond the MSMED timelines deductible only on payment (as opposed to "provision and deduct" type entries). These levers make carrying overdues costlier in both compliance and cash.
Overriding Effect of the Act
Section 24 of the Act provides that Sections 15–23 (the portion of Chapter V that ensconce the protections laid out above) prevail over anything to the contrary in any other law currently in force, including inconsistent contract terms. The Supreme Court has read this robustly: the MSMED mechanism prevails over general arbitration law, including the usual bar against a conciliator later acting as arbitrator, because Section 18 expressly allows the MSMED to conciliate and then arbitrate either itself or refer the dispute to institutional arbitration. Courts have also cautioned that parties should ordinarily pursue the statutory remedy (with its pre-deposit discipline) rather than detouring through writs.
Practical Pointers for Micro and Small Suppliers
- Ensure your Udyam registration is current, as Chapter V protections apply only to registered micro and small enterprises.
- Maintain a clear documentary trail - purchase orders, delivery challans, proof of acceptance (or absence of timely objection), and invoices - because the 15-day and 45-day timelines turn on these records.
- If payment begins to slip, consider initiating conciliation early through the MSME ODR channel. The statutory, monthly-compounding interest is intended to support timely settlement.
Practical Pointers for Buyers (Private Sector, PSUs, and Government)
- Build the 45-day statutory cap into payables calendars and approval workflows. For accounting purposes, assume an effective cost for delays (at prevailing bank rates) exceeding 17% per annum, compounded monthly.
- Increase awareness by training commercial and legal teams not to rely on extended contractual grace periods, since the Act overrides inconsistent contractual terms.
- Consider challenges to arbitral awards carefully, instead of fermenting litigation. Should any award be deemed fit for a challenge, budget for the mandatory 75% pre-deposit before pursuing a court challenge.
- Coordinate early with finance and tax teams to ensure smooth compliance and cashflows. Section 22 of the Act requires granular disclosures in audited financials, while Section 23 disallows the statutory interest as a tax deduction. Section 43B(h) of the Income-tax Act similarly defers deduction of overdue amounts to micro/small enterprises until actual payment within MSMED timelines. These are cash-flow-relevant obligations, not mere formalities.
Conclusion
Chapter V of the MSMED Act demonstrates how well-calibrated statutory design can shape commercial behaviour without resorting to coercion. Each element - the 45-day ceiling, the compounding interest rate, the dedicated facilitation councils, the pre-deposit requirement, and the associated disclosure and tax provisions - operates as part of a coherent framework. Together, they convert what was once a moral appeal for timely payment into an enforceable economic discipline. The framework rewards operational prudence and transparency while penalising delay not as a moral fault but as a calculable financial cost.
For India's contracting ecosystem, this is a quiet but meaningful shift. Predictable liquidity for small enterprises strengthens supply chains; disciplined payables management improves governance and investor confidence for larger buyers. The next phase of compliance will depend not merely on enforcement but on cultural adoption - embedding prompt payment as a standard of good business conduct. In that sense, Chapter V is more than a collection of penalties and procedures; it is a signal of policy intent, urging enterprises to treat fairness in commerce as a marker of both integrity and competitiveness. The mandatory nature of the statutory provisions conceived in the MSME Act creates a certainty in the mind of suppliers of goods and services as regards future expansion of business plans. Uncertainty in this regard is not conducive to the economy.